ASRJC H2 Prelim 2024 P2

1 © ASRJC Economics Department 9570 / JC2 Prelim / 2024 ASRJC JC2 Preliminary Examination 2024 H2 Economics Paper 2 Suggested Answers and Markers’ Comments Question 1 Market failure can occur due to imperfect information. For example, buyers know more information about their health problems than insurance providers in the healthcare insurance market while consumers of healthcare services may not be fully aware of the benefits of consuming healthcare services. (a) Explain how the market fails due to imperfect information in the market for healthcare services and the market for healthcare insurance. [10] (b) Discuss the policies that the Singapore government could adopt to ensure that the market for healthcare services operates efficiently. [15] Suggested answers (part a) Market failure refers to circumstances in which free, unregulated markets fail to achieve efficient allocation of scarce resources. Distortions in the market, for instance, imperfect information, prevent the price mechanism from allocating resources efficiently. In the real world, there is often a great deal of ignorance and uncertainty due to imperfect information. Imperfect information (and thus information failure) occurs when people have inaccurate, incomplete, uncertain or misunderstood data and so mak e potentially inaccurate choices. Market failure may arise due to lack of awareness of benefits in the market for healthcare services and due to adverse selection in the market for healthcare insurance. R1: Market fails due to lack of awareness of benefits in the market for healthcare services. Consumers who consider healthcare services may underestimate their potential benefits as they may not have complete information about the full longer -term benefits from consuming healthcare services such as they did not realise that they could be productive at work which enables them to earn a higher wage in the future. This is an example of imperfect information, creating a divergence between the consumers’ perceived Marginal Private Benefit (MPBperceived) and the actual Marginal Private Benefit (MPBactual) (Figure 1). MPBperceived represents the amount that consumers are willing and able to pay for each additional unit of healthcare service based on what they perceive to be the benefits they enjoy from its consumption. In this case, it is assumed that there are no positive or negative externalities, i.e. MPB actual = MSB and MPC=MSC. Intro R1: Market fails due to lack of awareness of benefits in the market for healthcare services.

2 © ASRJC Economics Department 9570 / JC2 Prelim / 2024 Figure 1: Underconsumption due to imperfect information Individuals will consume healthcare service up to Qe, where MPBperceived = MPC but the socially optimal output level is at Q s, where MSB = MSC. Hence, consumers’ imperfect information has led to an under -consumption of healthcare services. If consumers had full information of the private benefits of healthcare services and consume additional QeQs units, society’s welfare would increase because for these units of output, MSB>MSC (the additional benefit to society is greater than its costs). Instead, individuals consume only at Qe. And so there is deadweight loss to society which is indicated by the shaded area ABE (by summing the excess MSB over MSC) . Society could be made better off if more resources were allocated to the production of healthcare services. R2: Market fails due to asymmetric information in the market for healthcare insurance. Asymmetric information is when the economic agents (e.g. consumers and producers) involved in the transaction do not have the same amount of knowledge, resulting in a distortion of incentives and inefficient market outcomes. Adverse selection describes a situation in which the uninformed side of the market must choose from an undesirable or adverse selection of goods. It is market failure that results when products of different qualities are sold at a single price because of asymmetric information. As a result, too much of the low quality product and too little of the high quality product are sold. R2: Market fails due to adverse selection in the market for healthcare insurance. MPBActual = MSB MPBPerceived MPC= MSC Benefit, cost ($) Quantity of healthcare services 0 Qe Qs E B A

3 © ASRJC Economics Department 9570 / JC2 Prelim / 2024 Buyers of insurance might not divulge sufficient and accurate information about their health conditions to insurance companies. Buyers with higher risks (e.g. high risk individuals could be adopting unhealthy lifestyle) are more likely to buy health insurance with higher levels of coverage. This means that in the long run, insurance companies are likely to incur losses due to higher claims. In response, insurance companies will raise premiums (price of insurance) to cover their losses, but this will deter e ven more low risk individuals (e.g. low risk individuals who exercise regularly) from purchasing insurance. This will exacerbate the issue as the insurance companies will be left providing insurance to high -risk individuals, which may lead to an increase in losses, and a complete collapse of the insurance market (missing market for hea lth insurance). This leads to a missing market for health insurance for low -risk individuals and an under -allocation of resources to the provision of health insurance. Moral hazard is a situation where economic agents take greater risks than they normally would because the costs that would result would not be borne by the economic agents themselves. For example, moral hazard can arise when one party in a transaction change his or her behaviour in a way that is hidden from and costly to the other party. For example, an individual who buys health insurance may be less careful in maintaining his or her good health as the cost of future health problems is not as high as it would have been without the insurance. In the case of fire insurance, a h omeowner with fire insurance is likely to buy fewer fire extinguishers or take less care to prevent the occurrence of a fire as the insurance company now bears most of the cost of the damage in the event of a fire. These behaviours may result in higher losses for insurance companies, and they may be forced to close down, leading to an under - allocation of resources to the provision of insurance. Hence, market failure may arise due to lack of awareness of benefits in the market for healthcare services and asymmetric information in the market for healthcare insurance. Alternate R2: Market fails due to moral hazard in the market for healthcare insurance.

4 © ASRJC Economics Department 9570 / JC2 Prelim / 2024 There are two requirements in this question. For each requirement of the question, you will be assessed on your depth of analysis: Based on the depth of analysis for both requirements, you will be given a score: Depth of Analysis Mark A+A 10 A+C 8 – 9 A+K 7 C+C 6-7 A+0 6 K+C 5-6 C+0 4 K+K 2-4 K+0 1-2 Depth of analysis Descriptor Analytical An analytical explanation of question requirement with good application of relevant tools of analysis. Cursory An answer that shows cursory understanding of the question requirement and is lacking in AR and AP . Knowledge An answer that demonstrates weak understanding of the question requirement with many CK errors and possible QA errors.

5 © ASRJC Economics Department 9570 / JC2 Prelim / 2024 Marker’s Comments General comments: QA • The focus of the question is on imperfect information and there are two requirements for this question